What is an Investment Company?
An investment company is a financial organization whose main business activity is to hold and manage financial securities. These investments are done on behalf of the investors who have invested funds in the investment company. Investment companies may be publicly or privately owned. Goldman Sachs, Morgan Stanley, Deutsche Bank and Morgan Stanley are a few examples of global investment companies. These investment companies are different from commercial banks. While later manages deposits and loan requirements of individuals and institutions, investment banks go beyond the traditional investment options to help investors purchase and sell stocks, bonds, and other financial securities.
Types of Investment Companies
Investment requirements of various investors can be different from one investor to another depending on the type of returns that they require and the risks that they are willing to take. Some investors prefer to have more stable investment incomes (for example, pension or other fixed income earning investors) while others are willing to take significant risks in expectation of higher returns. Knowledge about various investment options is required to choose between investment options.
Exchange Traded Funds (ETF)
The behavior of exchange traded securities is often similar to the trading of shares in a stock exchange. An ETF can be a commodity, a bond or a basket of securities like an index fund. Dividends are paid from profits made to ETF security holders.
Unit Investment Trusts (UIT)
UIT is a fund structure where it allows funds to hold assets and provide profits that go straight to individual unit owners instead of reinvesting them back into the fund. Mortgages, cash equivalents, and properties are common types of investments of a UIT.
Open Ended Funds
Open ended funds are also referred to as ‘mutual funds’. They trade securities on a continuous basis and investors can buy and sell securities at any time. Due to this, the liquidity of open ended securities are high and the net asset value of an open ended security is stipulated by a regulator. Investment time period for open ended funds may be short-term (money-market funds) or long-term.
Money Market Funds
Treasury bills: A short-dated government security, yielding no interest but issued at a discount on its redemption price
Short-term municipal bonds: Debt securities issued by governments to finance capital projects
Commercial paper: Short-term unsecured promissory notes issued by companies
Long-term Funds
Treasury bonds– an interest-bearing bond issued by the government
Long-term municipal bonds
Closed Ended Funds
Unlike open-ended funds, these do not have the opportunity to be purchased and sold continuously; thus, the trading period is limited to a short period of time. At the end of the period, the offer to buy or sell shares will be closed for any new investors. The net asset value of a closed ended security is dependent on the demand and supply for the respective security.
How Do Investment Companies Work
In order to trade securities, an investment company should be listed in a stock exchange. Large scale global investment companies are often listed in more than one stock exchange. The investment decisions are made by a fund manager with regard to which securities should be bought and sold. There is also an independent Board of directors whose main responsibility is to protect the interests of the investors. The board of directors meets a couple of times every year to review the investment company’s performance and offer advice. The fund manager is usually appointed by the Board of directors. It is also not uncommon for investment companies to invest in other similar financial institutions.
Investment gearing is another common aspect associated with investment companies. Gearing is the borrowed funds generally utilized in long-term investment plans that have the ability make returns over a long period of time. One advantage often enjoyed by investment companies is that they can borrow at a lower rate compared to others.
Some investment companies make selected investments such as hedge funds, private equity investment companies, property investment companies, and venture capital companies. These types of selective investments often require specific criteria to be met by the investors in order to be qualified to invest in such securities. These types of investors are called ‘accredited investors’.
For example, to be categorized as an accredited investor to invest in a hedge fund, an investor should;
- Have a net worth of more than $1 million, owned alone or jointly with a spouse
- Have earned $200,000 in each of the past two years
- Have earned $300,000 in each of the past two years when combined with a spouse
- Have a reasonable expectation of making the same amount in the future
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